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When the price level increases in the economy,
we generally know that the value of money decreases.
However, what is the definition of money here?
Is it just currency? Or does it include assets, such as stocks and bonds?
Because if the price rises, due to the interest rate effect people sell their bonds and stocks. So the creditors charge a higher interest rate. Then the means that the value of assets becomes higher right?
Could someone explain this logic clearly? Thank you!
We need to keep two things seperate: the unit of account, and instruments.
The unit of account is a currency unit, like the U.S. dollar. When the price level (e.g., CPI) rises, the cost of goods measured in that unit of account rises.
We then have monetary instruments, like $20 bills, or bank accounts. Their value in the unit of account are unchanged. Therefore, they drop in value versus goods and services (as expected).
The prices of stocks and bonds may go up or down, for any number of reasons. Like other things, their value is measured in the unit of account. Therefore, it is unclear what relationship there will be between the price level change and financial asset prices. For example, CPI inflation has been close to a 2% annual rate since the Financial Crisis, and stock indices have generally risen much faster than that.
As for interest rates, the relationship is: bond price up, yield down (and vice versa).
It is the value of money as units of account, as a currency, for example the US dollar. If prices change the value of the dollar changes...so it changes compared with other currencies, like the Japanese YEN.
Exchange rates change...
